Hope despite gloomy outlook

Willi have a job in a year's time? That is a question many are asking as we enter the New Year and the views of economic pundits turn ever gloomier.

The fear is backed up by the latest survey of the hiring intentions of more than 2,000 UK employers undertaken by Manpower. The balance between companies intending to hire in the first three months of 2008 and those expecting to cut jobs fell to its lowest, though still positive, level for six years.

The Scottish economy has a tremendous record of job creation over the past 10 years. Despite a weaker GDP growth record, job creation was faster than in the UK economy, with 260,000 new jobs created between January 1997 and January 2007, an increase of 11.5 per cent as against 10.1 per cent in the UK. Moreover, the proportion of the Scottish workforce in jobs - the employment rate - rose above, and the unemployment rate fell below, the respective UK rates over the 10 years. But at the start of 2008 matters are more uncertain.

Scotland's economy is described by economists as an open economy, which means that due to its relatively small size and strong external linkages its economic fortunes are very much influenced by events elsewhere. Today the growth of demand in those economies to which Scotland is principally linked through trade and investment flows is slowing.

By the middle of this year most forecasters were predicting an orderly slow-down in the growth of the main economies due to the effects of higher oil prices, weaker housing markets, especially in the US, a decline in the value of the dollar, and a tightening of monetary policy to ward off incipient inflation.

But growth expectations remained reasonable with independent forecasters predicting growth in the UK of 2.7 per cent in 2007 and 2.4 per cent in 2008. And so for Scotland, we at the Fraser of Allander Institute were forecasting that Scottish GDP growth would slow slightly from 2.5 per cent in 2007 to 2.3 per cent in 2008, a rate of growth still much above Scotland's historic trend of 1.9 per cent.

However, by November, forecasters were on average predicting UK growth to be no more than 2 per cent in 2008, with some actually anticipating a fall in GDP next year. The explanation for the difference between now and then reflects the fall-out from the massive foreclosures in the sub-prime mortgage market in the US. This in turn led to significant and as yet unknowable losses for many of the world's major banks and hedge funds. Bank and interbank lending was restricted as a result, prompting a credit and liquidity crisis in the financial markets on a world scale. The trials and tribulations of Northern Rock are just the British tip of the iceberg that is the international credit crisis.

But what is also uncertain is the extent to which the crisis is spreading from the financial sector to the wider economy. The monetary authorities in the US, Europe and the UK have made significant amounts of credit available in an attempt to minimise the liquidity crisis. They hope that in so doing they will confine the effects to bank balance sheets and bank share prices, and so protect economic activity in general. Interest rates are also being cut because the liquidity crisis when added to the other forces contributing to a slowdown suggests that the risks to growth are now greater than the inflationary risk of higher oil prices and upward pressures on earnings.

Yet it seems unlikely that the economy at large will escape. There is evidence from the US that banks are widening the margins between lending and borrowing rates to non-financial businesses. The widening of these margins reflects perceptions of a heightened risk of recession and the prospect of default. It also appears to be driven by a desire to rebuild banks' balance sheets. Whatever the rationale, it suggests that debt service costs may also be about to rise while credit is less readily available. And this even when official interest rates are falling.

So there would now appear to be an internal domestic dynamic promoting a wider economic slowdown and recession as well as the direct impact on profits, jobs and share prices in the financial service sector of the sub-prime crisis.

What of Scotland? The openness of the economy means we cannot be insulated from developments elsewhere. The growth rate should slow. But to what extent is the key question.

The relative importance of banking and financial services to the Scottish economy might suggest that the direct effect of the crisis could be greater here. But that probably will not be the case. The losses due to sub-prime defaults posted by the Royal Bank, for example, are thankfully much less than comparable banks in other countries. Once again this highlights the value to Scotland of the excellent RBS management team in Gogarburn.

And there is further cause for optimism. In 1990, Scotland avoided the recession that occurred in the UK due to higher interest rates because households here were less indebted. In 2008, let us hope that Scottish prudence offers a bulwark against the harmful effect on output and jobs of the sub-prime credit crisis.

'The trials and tribulations of Northern Rock are just the British tip of the iceberg that is the international credit crisis'

Brian Ashcroft

'The Scottish economy has a tremendous record of job creation over the past 10 years'